U.S. Treasury yields fell Wednesday, as investors considered the outlook for monetary policy and financial markets for the coming year.
The yield on the 10-year Treasury dropped nearly 10 basis points to 3.789%. The 2-year Treasury yield edged down 4 basis points to 4.246%.
Yields and prices move in opposite directions. One basis point equals 0.01%.
In the last week of trading for 2023, investors considered the path ahead for interest rates and how this could impact the U.S. economy and financial markets.
Earlier this month, the Federal Reserve indicated that interest rates will be cut three times next year, with further reductions expected in 2025 and 2026, as inflation has “eased over the past year.”
Many investors have interpreted recent economic data, including the November U.S. personal consumption expenditure price index, as a sign that the Fed would be able to stick to its monetary policy expectations for next year.
Uncertainty remains about when the central bank will start cutting rates, although traders are pricing in an over 70% chance of rate cuts at its March meeting, according to CME Group’s FedWatch tool.
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Microsoft profit pops Microsoft issued quarterly revenue guidance above Wall Street estimates. The company also reported a surge in profit thanks to a slower pace of operating expense growth. Net income, at $22.29 billion, increased 27% from $17.56 billion, or $2.35 per share in the same quarter a year ago. The software maker’sshares jumped as much as 6% in extended trading on Tuesday.
Alphabet cloud business in spotlight Alphabet reported 11% revenue growth in the third quarter, as a rebound in advertising pushed expansion into double digits for the first time in over a year. Its shares dropped almost 7% in extended trading as the cloud business missed analysts’ estimates. For the quarter, it reported earnings per share of $1.55 vs. $1.45 expected by LSEG, formerly known as Refinitiv. Google Cloud revenue was $8.41 billion vs. $8.64 billion, according to StreetAccount.
Snap shares seesaw Snap shares initially soared as much as 20% in after-hours trading as the company beat on the top and bottom lines. It later settled to gain a little over 1% as investors digested news that some advertisers had paused spending following the onset of the war in the Middle East.
[PRO] Rising yields and war Yields are still rising, a war is raging, and it’s uncertain whether interest rates will stay higher for longer. Last week, the yield on the 10-year U.S. Treasury notewas above 4.9% for the first time since 2007. Investors continued to consider geopolitical risks from the Israel-Hamas war and the United States’ restrictions on artificial intelligence chip exports to China. Here’s how to trade the volatility, according to fund managers.
Markets are now slowly starting to come away from the tumultuous swings of last week when Treasury yields were high, and catalysts were few. That no longer seems an issue as investors can now look to a heavy flow of earnings to make their next call.
The Dow snapped four straight sessions of losses to end higher on Tuesday. U.S. Treasury yields were steady after slipping back below 5%, though they remained near 16-year highs.
Investors also had a spate of quarterly reports to parse. Coca-Cola posted earnings and revenue above estimates. Verizon recorded its best daily performance in almost 15 years after beating analysts’ expectations for both earnings and revenue. Audio streaming giant Spotify posted third-quarter results that topped expectations.
But the elephant in the room was Big Tech earnings.
Cloud revenue was key for both Microsoft and Alphabet. It’s a business that’s becoming even more significant with the emergence of generative artificial intelligence, which runs hefty workloads in the cloud.
The clear winner of this quarter’s cloud battle was Microsoft, powered by Azure as clients flocked to new generative AI tools in the cloud that have been enhanced with software from Microsoft-backed startup OpenAI.
Alphabet’s cloud unit tried to catch up with Azure and Amazon Web Services. But Google’s core advertising also weakened due to economic softening last year and increased competition from TikTok.
“If you want this stock to keep going higher, you’ve got to have cloud become more profitable,” said Lee Munson, chief investment officer of Portfolio Wealth Advisors. “It’s a third-rate cloud platform. We need to see it make money.”
Keeping to the AI theme, Qualcomm announced two new chips on Tuesday designed to run AI software — including the large language models, or LLMs, that have captivated the technology industry — without having to connect to the internet.
This could potentially boost the speed with which a high-end smartphone chip processes AI models.
People walk by the Fearless Girl bronze sculpture outside the New York Stock Exchange on April 21, 2023.
Spencer Platt | Getty Images News | Getty Images
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Microsoft profit pops Microsoft issued quarterly revenue guidance above Wall Street estimates. The company also reported a surge in profit thanks to a slower pace of operating expense growth. Net income, at $22.29 billion, increased 27% from $17.56 billion, or $2.35 per share in the same quarter a year ago. The software maker’sshares jumped as much as 6% in extended trading on Tuesday.
Alphabet cloud business in spotlight Alphabet reported 11% revenue growth in the third quarter, as a rebound in advertising pushed expansion into double digits for the first time in over a year. Its shares dropped almost 7% in extended trading as the cloud business missed analysts’ estimates. For the quarter, it reported earnings per share of $1.55 vs. $1.45 expected by LSEG, formerly known as Refinitiv. Google Cloud revenue was $8.41 billion vs. $8.64 billion, according to StreetAccount.
Snap shares seesaw Snap shares initially soared as much as 20% in after-hours trading as the company beat on the top and bottom lines. It later settled to gain a little over 1% as investors digested news that some advertisers had paused spending following the onset of the war in the Middle East.
[PRO] Bitcoin just broke above a key level At last, bitcoin has broken out of a tight trading range, potentially heralding greater highs from here. After oscillating between $25,000 and $30,000 for most of the year, touching the top end several times and stepping out of it briefly at one point in July, the flagship cryptocurrency shot up to $35,000 late Monday. Here’s what investors should expect.
Markets are now slowly starting to come away from the tumultuous swings of last week when Treasury yields were high, and catalysts were few. That no longer seems an issue as investors can now look to a heavy flow of earnings to make their next call.
The Dow snapped four straight sessions of losses to end higher on Tuesday. U.S. Treasury yields were steady after slipping back below 5%, though they remained near 16-year highs.
Investors also had a spate of quarterly reports to parse. Coca-Cola posted earnings and revenue above estimates. Verizon recorded its best daily performance in almost 15 years after beating analysts’ expectations for both earnings and revenue. Audio streaming giant Spotify posted third-quarter results that topped expectations.
But the elephant in the room was Big Tech earnings.
Cloud revenue was key for both Microsoft and Alphabet. It’s a business that’s becoming even more significant with the emergence of generative artificial intelligence, which runs hefty workloads in the cloud.
The clear winner of this quarter’s cloud battle was Microsoft, powered by Azure as clients flocked to new generative AI tools in the cloud that have been enhanced with software from Microsoft-backed startup OpenAI.
Alphabet’s cloud unit tried to catch up with Azure and Amazon Web Services. But Google’s core advertising also weakened due to economic softening last year and increased competition from TikTok.
“If you want this stock to keep going higher, you’ve got to have cloud become more profitable,” said Lee Munson, chief investment officer of Portfolio Wealth Advisors. “It’s a third-rate cloud platform. We need to see it make money.”
Keeping to the AI theme, Qualcomm announced two new chips on Tuesday designed to run AI software — including the large language models, or LLMs, that have captivated the technology industry — without having to connect to the internet.
This could potentially boost the speed with which high-end smartphone chip processes AI models.
U.S. Treasury yields rose on Wednesday with the 10-year hitting a fresh multiyear high as investors digested the latest economic data and considered the outlook for Federal Reserve interest rates.
The 10-year Treasury yield gained nearly 7 basis points to 4.911%, putting it above 4.9% for the first time since 2007. Meanwhile, the 2-year Treasury yield was trading almost 2 basis points up at 5.231%, around levels last seen in 2006.
Also notably, the 5-year Treasury moved as high as 4.937%, its top level since 2007.
Yields and prices move in opposite directions and one basis point equals 0.01%.
Investors considered fresh economic data as uncertainty about the path ahead for Fed monetary policy grew in recent weeks.
Housing starts accelerated in September, but rose as a slower-than-expected rate, according to data released Wednesday. Building permits fell in the month, but lost less than economists anticipated.
Retail sales figures for September, which were published Tuesday, increased by 0.7% for the month. That’s far higher than the 0.3% anticipated by economists surveyed by Dow Jones, and indicates resilience from consumers in light of higher interest rates and other economic pressures.
The data brought up renewed concerns over the outlook for interest rates, with some investors viewing it as an indication that rates may be hiked further or at least kept elevated for longer.
Markets are still pricing in a 90% chance that rates will remain unchanged when the Fed announces its next monetary decision on Nov. 1, but the probability of a December rate increase rose after Tuesday’s data, according to the CME Group’s FedWatch tool.
In recent days and weeks, various Fed officials have indicated that the central bank may be done hiking, especially as higher Treasury yields are contributing to tighter economic conditions. Further comments from policymakers are expected this week, including by Fed Chairman Jerome Powell, and investors are looking to their comments for hints about their policy expectations.
Upcoming economic data may also influence opinion among both investors and Fed officials.
Young customers buy second-hand luxury goods at a shopping mall in Shanghai, China, October 10, 2023.
CFOTO | Future Publishing | Getty Images
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U.S. markets wavered Tuesday as investors digested September’s U.S. retail sales report and third-quarter earnings from banks.
Consumers spent much more last month than economist had expected, which “puts us on track for a strong GDP number later this month,” said David Russell of TradeStation, an online trading and brokerage firm. Following the retail report, Goldman Sachs boosted its forecast for third-quarter gross domestic product by 0.3 percentage points to 4%. That’d be the highest quarterly growth since the last quarter of 2021.
It’s not just U.S. consumers who are splurging. Retail sales in China also jumped more than expected in September, buoying the country’s third-quarter GDP growth. China’s economy might finally be stabilizing, giving it a foundation on which to meet — or even exceed — Beijing’s target of about 5% economic growth this year. A resurgent China will boost global economic growth, but might raise new fears about inflation on renewed demand from the country.
Indeed, the specter of high inflation and, correspondingly, higher-for-longer interest rates, haunted the retail report, at least for the U.S. The hot spending data “gives the Fed zero reason to loosen policy, which keeps the 10-year Treasury yield pushing toward 5%,” said Russell.
Treasury yields jumped yesterday to multiyear highs, pressurizing stocks despite a good start to earnings season. (Of the companies that have reported so far, 83% have surpassed earnings estimates.)
Major U.S. indexes made hesitant moves in both directions. The S&P 500 slipped a miniscule 0.01%, the Nasdaq Composite lost 0.25% while the Dow Jones Industrial Average eked out the merest gain of 0.04%.
If bond yields continue rising, it’s possible earnings reports might not have a big effect on the overall stock market. As Chris Zaccarelli, chief investment officer of the Independent Advisor Alliance, put it, “It’s more the bond market driving the stock market at this point.”
An employee exits Goldman Sachs headquarters in New York, Jan. 17, 2023.
Bing Guan | Bloomberg | Getty Images
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Markets in holding pattern U.S. stocks struggled to make any meaningful moves Tuesday as Treasury yields rose — the 2-year yield hit a 17-year high. Europe’s Stoxx 600 index shed 0.1% amid mixed economic news. In the U.K., average earnings excluding bonuses grew 7.8% year on year, the first time since January that the pace has slowed. In Germany, economic sentiment in October improved more than expected.
Unstoppable U.S. consumer U.S. retail sales in September increased 0.7% month on month, far more than the 0.3% Dow Jones estimate, according to an advance report from the Commerce Department. Sales excluding autos rose 0.6%, three times the expected 0.2%. “The U.S. consumer cannot stop spending,” said David Russell, global head of market strategy at TradeStation.
Profit plunge at Goldman Goldman Sachsposted better-than-expected profit and revenue for the third quarter. Still, year on year, profit sank 33% to $2.058 billion and revenue dipped 1% to $11.82 billion. A breakdown of the bank’s revenue performance: Bond trading revenue fell 6%, equities trading revenue rose 8% and investment banking revenue inched up 1%. Investors weren’t impressed, causing Goldman shares to drop 1.6%.
Profit pop at Bank of America Bank of America beat Wall Street’s estimates for earnings and revenue in the third quarter. Profit popped 10% from a year ago to $7.8 billion and revenue rose 2.9% to $25.32 billion. Rising interest rates and loan growth juiced BofA’s interest income 4% to $14.4 billion. Investors cheered the results, rewarding the bank with a 2.33% bump in its shares.
[PRO] Buy gold, underweight stocks All three major indexes are in the green for October. But JPMorgan’s top strategist isn’t convinced. This is his advice: Buy gold. And don’t buy so many stocks. High bond yields, interest rates and the Israel-Hamas war remain risks to financial markets, he said.
Markets wavered Tuesday as investors digested September’s U.S. retail sales report and third-quarter earnings from banks.
Consumers spent much more last month than economist had expected, which “puts us on track for a strong GDP number later this month,” said David Russell of TradeStation, an online trading and brokerage firm. Following the retail report, Goldman Sachs boosted its forecast for third-quarter gross domestic product by 0.3 percentage points to 4%. That’d be the highest quarterly growth since the last quarter of 2021.
Narratives of a “soft landing” scenario, in which the U.S. economy subdues inflation without tipping into a recession, were reinforced by yesterday’s economic data. The “economy is on track for a soft-ish landing following healthy consumer activity, cooling inflation, and solid growth,” wrote UBS’ chief investment office.
A growing economy, in turn, is good news for corporate earnings and stocks. In the same note, UBS said “the profits recession is over,” meaning that earnings per share for S&P 500 companies should grow starting from the third quarter.
But the retail report isn’t all roses. The hot spending data will come “to the Fed’s dismay,” said Gina Bolvin, president of Bolvin Wealth Management, because the central bank “won’t like that higher rates are not deterring consumers from spending.”
Concurring, Russell said “it also gives the Fed zero reason to loosen policy, which keeps the 10-year Treasury yield pushing toward 5%.”
Indeed, Treasury yields jumped yesterday to multiyear highs, pressurizing stocks despite a good start to earnings season. (Of the companies that have reported so far, 83% have surpassed earnings estimates.)
If bond yields continue rising, it’s possible earnings reports might not have a big effect on the overall stock market. As Chris Zaccarelli, chief investment officer of the Independent Advisor Alliance, put it, “It’s more the bond market driving the stock market at this point.”
Investor and personal finance author Ric Edelman believes it’s a practical strategy to take chips off the table right now.
“It comes down to behavioral finance. It comes down to human emotion,” the Edelman Financial Engines founder told CNBC’s “ETF Edge” this week. “Do you have the stomach? Does your spouse have the stomach to hang in there if things get ugly like they did in ’01, ’08, 2020? Can you hang in there?”
Edelman added there’s a “laundry list of reasons” to be cynical right now. He includes struggles in the real estate market, high interest rates, government shutdown risks and the Israel-Hamas war.
“It’s easy to be negative and that can cause you to say, ‘Why do I want to put myself in a position of maybe losing another 20% or 30% of my money when I’ve already amassed an awful lot of money and I am already in my ’60s or ’70s and I need the safety and protection and by the way get five percent in my bonds or U.S. Treasury or my bank CD? Why don’t I just park it? Earn 5%. Call it a day,’ he said.
Edelman acknowledges the strategy could be less profitable, but he suggests it’s important to sleep better at night.
“I’m not sure everybody in the investment world is acting logically as opposed to emotionally. You’ve got to know yourself,” said Edelman.
The Capital Group’s Holly Framsted is also seeing investors de-risk, and her firm is trying to cater to them by offering a new batch of exchange-traded funds focused on fixed income.
“We’re seeing increased interest in short-duration fixed income,” said the firm’s head of global product strategy and development.
Framsted speculates the investors are making the move to short-duration funds in response to the volatility of today’s market.
“[The Capital Group Core Bond ETF] was among the original six funds that we launched,” Framsted said. “We’re seeing interest among our client base who tend to be longer-term oriented in nature across the full spectrum. But certainly, a lot of conversations in the short-duration space given the environment that we’re in.”
The firm’s bond ETF is virtually flat since its Sept. 28 launch. The Capital Group managed more than $2.3 trillion as of June 30, according to the firm’s website.
Nvidia headquarters in Santa Clara, California, US, on Monday, June 5, 2023.
Marlena Sloss | Bloomberg | Getty Images
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Tech rebound U.S. stocks started the week on a positive note, thanks to a rebound in chipmakers and technology stocks. European markets traded mixed. The regional Stoxx 600 index inched up 0.15%, buoyed by a 4.35% increase in Philips. However, the U.K.’s FTSE 100 slid 0.23% and Spain’s IBEX 35 dipped 0.05%.
Nvidia, again Nvidia shares popped 7% to hit $437.43 after Morgan Stanley released a note reiterating the company’s strengths. “Nvidia remains our Top Pick, with a backdrop of the massive shift in spending towards AI, and a fairly exceptional supply demand imbalance that should persist for the next several quarters,” the bank wrote.
Back to golf, not banking Goldman Sachs’ former CEO Lloyd Blankfein can’t imagine returning to his old firm, he told CNBC. Blankfein was disputing a New York Times article that “misquoted” him. “I never used the word ‘return’,” Blankfein said. “I think my days working 100-hour weeks are over.” He then ended the conversation and went back to his golf game.
The Russian ‘Goldilocks’ for China? China’s been one of Russia’s staunchest supporters since Moscow’s unprovoked invasion of Ukraine. But analysts think China wants Russia in a “Goldilocks” situation: Neither so strong that it could challenge Beijing, nor too weak where it leaves China isolated against the West. Other observers, however, argue China’s already risking geopolitical capital to help Russia.
[PRO] Rate cuts next year? Goldman Sachs thinks inflation will fall to a level that the Federal Reserve is comfortable with by the first half of next year. The Fed, in turn, will begin lowering interest rates before the end of June 2024, the bank forecast.
Technology stocks and chipmakers helped major U.S. indexes regain their footing after ending last week in the red. The S&P 500 gained 0.58%, the Dow Jones Industrial Average inched up 0.07% and the Nasdaq Composite advanced 1.05%.
While that’s just a single data point, yesterday’s positive market movement echoes Oppenheimer chief investment strategist John Stoltzfus’ argument that the last two week of losses didn’t signal the end of the bull market. Rather, it was “a pause that refreshes” — a healthy adjustment to “oversold market conditions,” Stoltzfus wrote.
Still, stocks face pressure from rising bond yields. The two-year U.S. Treasury yield is a hair’s breadth away from 5% while the 10-year yield is 4.2% — pretty healthy returns for a risk-free investment. “Fixed income just looks relatively attractive, especially [relative to] where [we] were just a couple of years ago,” said Kevin Gordon, senior investment strategist at Charles Schwab.
At the same time, higher yields mean lower prices. That “creates the opportunity to buy bonds at a real rate that we haven’t seen in well over a decade,” Ashish Shah, chief investment officer of public investing at Goldman Sachs Asset Management, told CNBC.
The tussle between stocks and bonds, however, seems a pretty good problem to have. Recent data show both inflation receding and the U.S. economy expanding more than forecast. Whatever choice investors make, then, it’s made under a backdrop of heathy conditions — something rare since the pandemic.
Or, as Adam Crisafulli, founder of market intelligence firm Vital Knowledge, put it, “We don’t think investors should dive too far down rabbit holes of despair.”
Investors swarmed into U.S government bonds Monday after the collapse of Silicon Valley Bank and subsequent government backstop of the banking system. The rush sent Treasury yields tumbling.
The yield on the 2-year Treasury was last trading at 4.005%, down nearly 59 basis points. (1 basis point equals 0.01%. Prices move inversely to yields.)
The yield has fallen around 100 basis points, or a full percentage point, since Wednesday, marking the largest three-day decline since Oct. 22, 1987, when the yield fell 117 basis points. That move followed the Oct. 19, 1987 stock market crash — known as “Black Monday” in which the S&P 500 plunged 20% for its worst one-day drop. The move was bigger than the 2-year yield slide of 63 basis points that took place in three days following the 9/11 attacks.
The yield on the 10-year Treasury was down by more than 15 basis points at 3.543%.
The financial shock also caused investors to rethink how aggressive the Federal Reserve will continue to be with rate hikes, helping to send short-term yields lower. The central bank is meeting next week and was largely expected to raise rates for a ninth time since March of last year — but that was before Silicon Valley Bank’s collapse happened last week.
Goldman Sachs no longer thinks the Fed will hike rates, citing “recent stress” in the financial sector. However, traders are pricing in about 2-to-1 odds that the Fed raises its benchmark borrowing rate by 0.25 percentage point at the March 21-22 meeting.
And the market is also anticipating that by the end of the year, the central bank will lop off 0.75 percentage point in cuts, taking the rate down to a target range of 4%-4.25%. Current pricing indicates a terminal rate of 4.75% by May.
“In the wake of SVB, interest rate yields have gone lower and will most likely continue to go lower as the Fed’s hand is being forced to be less hawkish in the coming months while the banking sector uncertainty plays out,” said Jeff Kilburg, founder & CEO of KKM Financial.
The 2-year Treasury yield rose to 5.085% last week, its highest since June 2007 before the sudden decline.
U.S. 2-year Treasury yield
Investors also braced themselves for a series of key inflation data due this week. February’s consumer price inflation report, including the latest reading of the core inflation rate, is expected Tuesday, followed by wholesale inflation data on Wednesday.
That comes after Federal Reserve Chairman Jerome Powell indicated last week that the central bank’s upcoming interest rate decision would be “data-dependent.” Powell also suggested that interest rates would likely go higher than expected as the Fed’s battle with inflation continues.
Citigroup economists think the Fed will follow through with a 25 basis-point increase next week rather than hold off in response to the banking tumult.
“Doing so would invite markets and the public to assume that the Fed’s inflation fighting resolve is only in place up to the point when there is any bumpiness in financial markets or the real economy,” Citi economist Andrew Hollenhorst said in a client note.
As Wall Street gears up for key inflation data, Wells Fargo Securities’ Michael Schumacher believes one thing is clear: “The Fed is not your friend.”
He warns Federal Reserve chair Jerome Powell will likely hold interest rates higher for longer, and it could leave investors on the wrong side of the trade.
“You think about the history over the last 15 years. Whenever there was weakness, the Fed rides to the rescue. Not this time. The Fed cares about inflation, and that’s just about it,” the firm’s head of macro strategy told CNBC’s “Fast Money” on Monday. “So, the idea of lots of easing — forget it.”
The Labor Department will release its January consumer price index, which reflects prices for good and services, on Tuesday. The producer price index takes the spotlight on Thursday.
“Inflation could come off a fair bit. But we still don’t know exactly what the destination is,” said Schumacher. “[That] makes a big difference to the Fed – if that’s 3%, 3.25%, 2.75%. At this point, that’s up in the air.“
He warns the year’s early momentum cannot coexist with a Fed that’s adamant about battling inflation.
“Higher yields… doesn’t sound good to stocks,” added Schumacher, who thinks market optimism will ultimately fade. So far this year, the tech-heavy Nasdaq is up almost 14% while the broader S&P 500 is up about 8%.
Schumacher also expects risks tied to the China spy balloon fallout and Russia tensions to create extra volatility.
For relative safety and some upside, Schumacher still likes the 2-year Treasury Note. He recommended it during a “Fast Money” interview in Sept. 2022, saying it’s a good place to hide out. The note is now yielding 4.5% — a 15% jump since that interview.
His latest forecast calls for three more quarter point rate hikes this year. So, that should support higher yields. However, Schumacher notes there’s still a chance the Fed chief Powell could shift course.
“A number of folks in the committee lean fairly dovish,” Schumacher said. “If the economy does look a bit weaker, if the jobs picture does darken a fair bit, they may talk to Jay Powell and say ‘Look, we can’t go along with additional rate hikes. We probably need a cut or two fairly soon.’ He may lose that argument.”
U.S. Treasury yields rose Friday after jobs data came in much better than expected.
The 10-year Treasury yield was up more than 12 basis points at 3.526%. The 2-year Treasury was up roughly 20 basis points to 4.299%.
Yields and prices move in opposite directions and one basis point equals 0.01%.
Nonfarm payrolls increased by 517,000 for January, notably above the 187,000 additions estimated by Dow Jones. The unemployment rate fell to 3.4%, lower than the 3.6% expected by Dow Jones.
The data underscored the stickiness of the labor market. The Fed has been trying to cool the economy through monetary policy measures, including interest rate hikes. At the conclusion of its latest meeting on Wednesday, the central bank increased rates by 25 basis points, but also said it was starting to see a slight slowdown of inflation.
The near $1.4 trillion collapse of the crypto market in 2022 didn’t make a dent to traditional assets like stocks or to the real economy.
But one academic has warned that the failure of a major stablecoin could have an impact on the U.S. bond market, marking a potential new area that investors need to keep an eye on as contagion continues to spread across the industry.
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Stablecoins are a type of digital currency that is supposed to be pegged one-to-one with a fiat currency such as the U.S. dollar or the euro. Examples include tether (USDT), USD coin (USDC) and Binance USD (BUSD), which are the three biggest stablecoins.
Those kinds of coins have become the backbone of the crypto economy, allowing people to trade in and out of different cryptocurrencies without needing to convert their money to fiat.
Issuers of those stablecoins say they are backed by real assets such as fiat currency or bonds so that users can redeem their token one-for-one with a real asset.
Tether says that more than 58% of its reserves are held in U.S. Treasury Bills, accounting for around $39.7 billion. Circle, the company behind USDC, has around $12.7 billion worth of Treasurys in its reserve. Paxos, which issues BUSD, said it has around $6 billion of U.S. Treasury bills. All those figures are from the companies’ latest reports which were issued in November.
But while there are no signs of major stablecoins collapsing, Eswar Prasad, an economics professor at Cornell University, said it’s something regulators he’s spoken to are worried about because of the impact it could have on traditional financial markets. That’s because a potential run on a stablecoin — where large swathes of users look to redeem their digital currency for fiat — would mean the issuer has to sell off the assets in their reserve. That could mean dumping large amounts of U.S. Treasurys.
“And I think [the] concern of regulators is if there were to be a loss of confidence in stablecoins … then you could have a wave of redemptions, which will in turn mean that the stablecoin issuers have to redeem their holdings of Treasury securities,” Prasad told CNBC at the Crypto Finance Conference in St. Moritz, Switzerland, this week.
“And a large volume of redemptions even in a fairly liquid market can create turmoil in the underlying securities market. And given how important the Treasury securities market is to the broader financial system in the U.S. … I think regulators are rightly concerned.”
A growing number of voices have warned about the impact that a “run” on stablecoins could have on traditional financial markets.
Just_super | Istock | Getty Images
Prasad advises regulators around the world on policy related to cryptocurrencies.
The academic warned that if such a run were to occur when bond market sentiment was “very fragile as it is in the U.S. right now,” there could be a “multiplier effect” thanks to large selling pressure on Treasurys.
“If you have a large wave of redemptions that can really hurt liquidity in that market,” Prasad said.
The Federal Reserve hiked interest rates several times in 2022 and is expected to continue to do so this year as it looks to tame rampant inflation. The U.S bond market had its worst year on record in 2022.
Stablecoins account for about $145 billion of value out of the $881 billion that the entire cryptocurrency market is worth, so they are significant. And there have been failures already.
Last year, a coin called terraUSD collapsed. It was dubbed an algorithmic stablecoin, so called because it maintained its one-to-one peg with the U.S. dollar via an algorithm. It was not backed in full by real assets such as bonds as USDC, BUSD and USDT are. The algorithm failed and terraUSD crashed, sending shock waves across the crypto market.
The U.S. Federal Reserve also warned in a report in May 2022 that “stablecoins remain prone to runs, and many bond and bank loan mutual funds continue to be vulnerable to redemption risks.”
Bill Tai, a well-known venture capitalist and crypto industry veteran, said he doesn’t think there will be a collapse of any of the major stablecoins, but said that scrutiny on this type of cryptocurrency “has gone up for good reason.”
“I think just like in our traditional finance industry, where people got caught off guard by hidden contagion inside the subprime market during the great financial crisis, there could be a pocket or two of leverage on some of the assets that purport to support stablecoin,” Tai told CNBC in an interview Thursday.
Tai likened a potential stablecoin blowup to a surprise event like the subprime mortgage crisis, which began in 2007. Lenders offered mortgages to borrowers with poor credit, leading to defaults and contributing to the financial crisis. It came as somewhat of a surprise.
“And if one of those (stablecoins) goes down, there will be another downdraft,” Tai added.
